For anyone considering a career in economic forecasting, the Bank of England’s inflation report for August 2007 ought to be required reading. A graph illustrating its Monetary Policy Committee’s ‘best collective judgment’ of annual economic growth two years ahead is fixed around a central prediction of 2.5 per cent, with extreme boundaries of 0.8 per cent and 4.2 per cent. But after two years, economic growth was running at –5.6 per cent, and the economy had just completed its fifth consecutive quarter of negative growth. The finest minds of Threadneedle Street could not see two years ahead.
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In this case, the Bank of England could not even see a few days ahead, because no sooner had the ink dried on their inflation report than, on 9 August 2007, the international credit markets froze, precipitating the Northern Rock crisis, followed a year later by the collapse of Lehman Brothers and what was to become the deepest recession that the developed world had seen since the 1930s. When touring a business school, the Queen famously asked: ‘Why did no one see it coming?’ The answer is simple: economics cannot predict the future, because there are too many variables.
Ten years on, there is scant sign that this lesson has been learnt. Shocks are inevitable; the best we can do is prepare for them by keeping debt low and controlling public borrowing. Yet we are now in the tenth year of markets pumped up by low interest rates and easy credit — in some forms it is even easier to obtain than it was a decade ago. The world of 125 per cent mortgages has gone, only to be replaced by personal contract purchase loans on cars, pushed at people on low incomes.
The household savings rate — the proportion of household income which is being put aside for a rainy day — has fallen to under 2 per cent, not just lower than pre-crash levels, but the lowest recorded in more than 50 years of data. The value of unsecured loans has grown to £200 billion for the first time since the credit crunch, and consumer credit is growing at an even higher rate than it was then. Just as in 2007, few bother to ask who is ultimately carrying the risk of all this lending, and with debt being traded around the world as a commodity, through the means of ever more complex financial instruments, we are unlikely to find out until it is too late.
Well might Bank of England governor Mark Carney warn of excessive growth in credit, yet he is himself feeding it with interest rates of 0.25 per cent. The last reduction in rates was made last August, to ward off a Brexit referendum recession which turned out to be nothing more than a figment of his imagination: economic growth accelerated after the vote. Yet not even that drop in interest rates has been reversed. When the Bank of England reduced its rate to 0.5 per cent in the depths of the 2008/09 recession, we were told that it was an emergency measure. Instead, the date for reverting to ‘normal’ monetary policy has been put off to the point at which interest rates of virtually zero have themselves come to be regarded as normal. Nor has quantitative easing been unwound. Britain, and the developed world in general, remain hooked on the financial equivalent of the hair of the dog. Monetary policy has become scared of sobriety.
If there was one lesson that the government should have taken from the 2008/2009 crisis, it is how quickly the public finances can turn when the economy goes into recession. Ten years ago, as he left the Treasury to become Prime Minister, Gordon Brown was running a budget deficit of £40 billion. Within three years it was £150 billion. Closing the deficit has become, like raising interest rates, a project which keeps being delayed. First, it was going to take one parliament, then two. Now we are told that the government will not balance the books until the middle of the next decade.
Why? Not because the hazards of ever-increasing public debt have gone away, but because ministers feel it has become politically troublesome to close the gap between revenue and expenditure — that the public has grown tired of ‘austerity’, as many like to call fiscal discipline. Now, as before the last crash, they are addicted to debt.
There is no sign of any planning in the government’s spending plans for a possible recession — just an assumption on the part of Treasury forecasters that the economy will grow ad infinitum at an annual rate slightly to either side of 2 per cent. Yet there is nothing unpredictable about recessions. As the Office of Budgetary Responsibility (OBR) asserted in a little-noticed report last month, the chance of a recession in any one five-year period is 50 per cent. That is nothing to do with Brexit, just an observation of the economic cycle over many decades.
We have already gone nearly eight years since the end of the last recession. We may be lucky, as we were between 1992 and 2008, to go a few more years without suffering two quarters of negative growth — the official definition of a recession. But sooner or later our luck will run out. What will matter then is: how well prepared are our government finances, and how robust is our financial system? There is little cause to feel confident about either.